Battle to find another way

As recognition of “third way” retirement income solutions continues to build, it is clear a political debate has also kicked-off that could have far-reaching consequences for the rapidly growing number of people retiring with money purchase pensions.

Lifetime annuities have in the past dominated the retirement income market, with the more costly and risky option of income drawdown mainly appealing only to the wealthy and financially sophisticated. It is only in the last year that “third way” – also called “hybrid” plans because they combine some of the income security of a lifetime annuity with some of the flexibility of drawdown – have become available.

However, in the recent pre-Budget report Alistair Darling announced the government would not change the tax rules to enable the further development of hybrid plans because it would “potentially benefit only a small number of consumers with large pension savings”.

The chancellor seems to have overlooked the point the wealthy few are already well served through access to good financial advice and sophisticated income drawdown plans. It is the mainstream market, those reaching retirement with medium-sized pension pots, which is in desperate need of more advice, innovation and choice.

The Conservatives appear to be taking a different view. Shadow Treasury financial secretary Mark Hoban recently pointed out that the huge shift towards money purchase-style pension arrangements means more individuals are accumulating reasonable pension pots which is likely to increase demand for income solutions that allow them to keep control post-retirement. He believes allowing more flexible products would encourage greater pension saving.

“Third way” plans recognise this growing demand for new options and provide solutions to those who question the wisdom of locking in to the fixed benefits of a lifetime annuity too early in retirement.

Most people reaching retirement at age 60-65 are in good health and can look forward to two or three decades more life – one-in-10 is likely to live to 100, according to the most recent Government Actuary’s Department figures. There is no compulsion to buy a lifetime annuity until age 75, but typically people buy at the point of retirement when they are only eligible for healthy lives annuity rates and when the income uplift from mortality pooling is very small.

Of course, those who delay buying a lifetime annuity have to weigh up the possibility of annuity rates falling in the future. But this risk should be balanced against a host of other economic and personal factors.

Inflation remains close to historic lows, raising the question about whether this is a good time to lock-in to current rates.

Perhaps more important is the impact of failing health during retirement. Although life expectancy has risen, we spend proportionally more of our retirement in poor health with government figures from the Office for National Statistics putting healthy life expectancy for men at 67 years and 68.8 for women. It makes little sense to accept a healthy life annuity rate when those that wait until closer to age 75 are more likely to be eligible for the higher income of enhanced or impaired life rates.

Those who opt to delay buying a lifetime annuity for perhaps a decade will have far more visibility over their future financial needs. If they no longer have a partner, there is no need to pay for a spouse’s pension. Death benefits protecting their pension pots can also be renewed until later in life.

They can also use “third way” products to manage their income more efficiently in early retirement, perhaps drawing down a lower or higher income than they would get from an equivalent lifetime annuity depending on their circumstances.

Retirement now accounts for such a long period of the average person’s life that new income solutions are required to reflect the changing phases as people move from active retirement to passive, then on to the care stage. Those who keep their options open may also benefit from future product innovation and rule changes.

Although the government seems to be sticking to its guns, the pressure for change is building. The guarantees and flexibility of “third way” thinking means people can now keep their options open while controlling investment risk, benefiting from a more targeted income solution in early retirement before taking the final irrevocable plunge into a lifetime annuity later in life.

Kim Lerche-Thomsen is founder and chief executive of Living Time